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Important tip for Buyers of businesses
One important thing for Buyers looking to purchase a business is for them to recalculate EBITDA and SDE if there are multiple owners of the business. It is easy for a Seller or Seller’s advisor to overlook the true SDE and EBITDA when there are multiple owners of a business.
For example, see the Line 12 number of $38,957 below for Compensation of Officers for a tax return.
It seems like SDE and EBITDA would be easy to calculate, just add back the $38,957 for SDE and EBITDA would remain unchanged. If there is only one Seller that calculation would be correct, but what if there are multiple Sellers? How does that change EBITDA and SDE? Does it changes SDE and EBITDA?
The Buyer would need to replace one of the Sellers. This cost to replace the Seller would not be added back to arrive at EBITDA, it would be subtracted. Both EBITDA and SDE would be reduced. The reason for this is the Buyer would incur the cost of replacing one of the Sellers. Here is one other thing to consider: is the current wage of the Seller who is going to be replaced more or less than the is receiving less than the cost to replace them? Whatever that cost is going to be, that is the amount of expense that would be included in the calculation of SDE and EBITDA.
For example, let’s assume the cost to replace one of the owners is $25,000. See the correct calculations below:
Erroneous Calculation Correct Calculation with Multiple Sellers
Net Income $X,XXX,XXX $X,XXX,XXX
Add:
Interest XX,XXX XX,XXX
Inc Taxes XX,XXX XX,XXX
Deprec XX,XXX XX,XXX
Amort XX,XXX XX,XXX
Cost to replace
Owner XX,XXX (25,000)
EBITDA XX,XXX XX,XXX
Plus:
Owner Wages $38,957 $38,957
Cost to Replace
Owner XX,XXX XX,XXX
SDE/Cash Flow $XXX,XXX $XXX,XXX
The result of the above is that EBITDA and Cash Flow are reduced by $25,000. We used $25,000 as a basis for the example, but the number could far greater impact on the business because, let’s assume a 3x multiple of SDE as a basis for value, then the value of the business would actually be $75,000 less due to the correct calculation.
This is a critical part of an acquisition: Buyers beware!
Sold – Business with customers across the Western United States
Rick Krebs of Business Sales Group is pleased to announce the sale of another business. Rick Krebs was the sale-side advisor for this successful transaction. This sale is private and the team (Rick Krebs and Heather Krebs) at Business Sales Group is pleased to have been a part of this sale. We found a great buyer who is very pleased with his purchase and excited to move ahead with the explosive growth of this business. They increased sales dramatically within the last 30 days and that rapid expansion is expected to continue. Congratulations to the Buyer and Seller!
Business Sales Group is a M&A Advisory/Business Brokerage located in Utah that advises clients across the Rocky Mountain Region. Rick Krebs and Heather Krebs are the two principals. Visit www.Bsalesgroup.com for information or to obtain a business valuation, visit www.BusinessValuationsGroup.com
Just Sold – Motorsports Dealership
Business Sales Group is pleased to announce the successful sale of Twin Pines Motorsports. This dealership sells, services, and leases Arctic Cat ATVs, UTVs and snowmobiles. They also repair and service all types of motorsports machines.
Congratulations to Mitch and Barbara (Buyers) and Kurtis and Carla (Sellers). They were ranked by customers as the #1 Arctic Cat dealership for customer satisfaction in 3 Western States.
SOLD – another business
Our Small Business Division just sold another great business in Heber City, UT. We sold the Dickeys restaurant on main Street. The new husband and wife owner/operators are excited to move forward developing the walk-in and catering business. Dickeys is the largest barbecue chain in America with over 500 franchises. Congratulations to Kevin and Barbara and their family.
Acquired – Ohio Dental Practice
Business Sales Group – M&A Division is pleased to announce the completion of another acquisition of a dental practice. The practice is located in Ohio. We wish to congratulate the owner/dentist for being great to work with through the process. This is part of an ongoing engagement where Business Sales Group represents the Buyer as his agent, overseeing the entire acquisition process including practice valuation.
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By Rick Krebs – Valuations Expert, CPA, Mergers and Acquisitions Professional, Business Broker. Rick brings a unique blend of sales, entrepreneurial, and financial experience to Business Sales Group. He began his career as a CPA, working in Nevada and Utah where valuable financial experience was gained. He uses those skills every day. He graduated with a Master’s of Science Degree and Bachelor’s Degree from Utah State University. As a business owner he started Liberty Mortgage, a mortgage bank licensed in 23 states nationwide. He eventually sold the successful company to an investor from California. He has been in the M&A space helping people sell their businesses since July, 2010. During his first year as a business broker with BRC, he listed and sold more businesses than the entire office combined.
As a sale-side and buy-side advisor for Mergers and Acquisitions transactions Rick’s advisory, accounting, and management skills are invaluable when advising sellers as they maneuver the intricate details of the deal through closing. Rick is also a CNA (Certified Negotiation Expert) which helps him negotiate the most favorable terms for clients in a transaction.
TOP 6 VALUE DRIVERS OF BUSINESS VALUE
Financial Performance
When a financial buyer is contemplating a purchase, the number one metric they use to measure value is financial performance. It is important that the financial information being presented is accurate. Are your books accurate and up to date? Do you just do the minimum for financial reporting or do you have good, CPA prepared financials?
What about trends? Are there patterns of growth or decline in your business? If in decline, are there good reasons for the decline? Detailing these reasons is crucial. Accurate and up-to-date are important for determining how the company rates in its industry and amongst competitors. A comparison to industry ratios can identify strengths and weaknesses in the business. These factors have a significant impact on business value.
Management
What is the experience level of the current management team? How long have they been with the business? Are they planning to retire soon? These are common questions asked by Buyers who are looking at a business. They often want to see an Organization Chart detailing key management personnel. The better the management, the higher the price tends to be. Also, if the business runs better in the owner’s absence than in his or her presence, it will be valued higher. What is the average length of employment amongst your staff? A responsible business buyer will be looking for opportunities where the current staff, especially management, will remain in place, following the current owner’s exit from the business. Having key employee contracts, non-compete agreements, but more importantly a loyal, dedicated staff that is committed to the company’s success regardless of ownership change will be highly valuable to a prospective buyer and thus reflected in a business valuation.
Competition
Competitive landscape is a value driver for a business. Highly competitive market segments tend to suppress prices while fragmented markets with little competition tend to bring premium prices. Does your company compete in a clearly defined market niche which is defensible? Or, have your products or services become a commodity that is becoming more difficult to defend?
Proprietary Assets
If proprietary assets such as patents are sold along with the business it increases the value and price of the business. Often these assets are valued individually within the business valuation. Has your company developed a unique application, tool or technology as part of its ongoing operations? Does it give you a competitive advantage? If so, this proprietary innovation or intellectual property can be positioned as a key value driver for your business. Technologies or processes do not have to be patented to carry value but privacy and confidentiality must be maintained. It is critical that non-compete and confidentiality agreements be strictly adhered to and enforced by the company, before and after a transfer of ownership. The benefits, application and purpose of your proprietary technology should be explained to a business valuation expert.
Intangibles, or intellectual property and human resources can be protected and leveraged through a combination of business strategies and legal protections. Business strategies include incentive compensation plans to recognize, reward and retain high-performing employees. Legal protections include requiring key employees to sign non-compete agreements, registering Trademarks and Copyrights, and taking steps to protect proprietary information/trade secrets such as recipes and formulas. Contracts with key players, including partners, customers and suppliers are also important.
Customer Concentration
High customer concentration levels have a negative impact on price. This is due to the risk imposed by a business having a single customer who can be lost which would be devastating to the business. Low levels of customer concentration are favorable to a higher value of the business. Do you have one or two major customers that account for more than 25% of your gross sales? What would happen to the value of your company if you lost one? A good overview and a rating analysis of the customer base can be beneficial not only for added value, but is also crucial for where, how and when you advertise — not to mention a much better understanding of your accounts receivable and aging.
Opportunity
The opportunity of the business tends to be value driver for strategic buyers. Strategic buyers buy a business more based on what they can do with the business than what the numbers show. An example of this would be a competitor buying out a competitor to increase market share. Companies also grow through vertical integration and acquisition of suppliers and customers.
Conclusion
These Business valuation drivers are important metrics to monitor when considering what will drive the value of a business. If you are considering a sale of your business or just curious, these can be used as benchmarks to help you increase the value of your business.
By Rick Krebs – Valuations Expert, CPA, Mergers and Acquisitions Professional, Business Broker. Rick Krebs brings a unique blend of sales, entrepreneurial, and financial experience to Business Sales Group. He began his career as a CPA, working in Nevada and Utah where valuable financial experience was gained. He uses those skills every day. He graduated with a Master’s of Science Degree and Bachelor’s Degree from Utah State University. As a business owner he started Liberty Mortgage, a mortgage bank licensed in 23 states nationwide. He eventually sold the successful company to an investor from California. Rick Krebshas been in the M&A space helping people sell their businesses since July, 2010. During his first year as a business broker with BRC, he listed and sold more businesses than the entire office combined.
As a sale-side and buy-side advisor for Mergers and Acquisitions transactions Rick Krebs’ advisory, accounting, and management skills are invaluable when advising sellers as they maneuver the intricate details of the deal through closing. Rick is also a CNA (Certified Negotiation Expert) which helps him negotiate the most favorable terms for clients in a transaction.
USING MULTIPLE ARBITRAGE TO MAXIMIZE THE VALUE OF YOUR BUSINESS
According to Rick Krebs, Principal at Business Sales Group and Business Valuations Group, here are 3 ways for you to maximize the value of your business using multiple arbitrage.
- Make an investment in your books. It is common among business owners to view the cost of financial reporting (keeping the books and accounting) as an expense. It is seen as a “necessary evil”. The cost of the accounting department is viewed as a necessary expense incurred to do business. This view is wrong. I suggest you have a paradigm shift in regards to how you view the financial reporting for your business. Make an investment to have good books and records that will pay dividends of over 875%. One word of warning about this. You may experience some growing pains here. I’ve seen many businesses that have literally outgrown their CPA. You will need to “get real” with yourself and honestly assess the advice you are getting, the timeliness of service and quality of the reporting. Do not be loyal to a fault here. If it’s time to let go, then cut the strings.
- Convert to full GAAP/Accrual accounting for internal reporting purposes. Business owners sometimes think that merely keeping the books on a cash basis forces them to not do full accrual/GAAP accounting for in-house purposes. This is simply not true. Keep the books on an accrual/GAAP basis in-house and on a cash basis for tax purposes to maximize the selling price of your business. Eventually the IRS will force you use accrual accounting for tax reporting, but your CPA will generally recommend that you stay on a cash basis as long as you can. Be prepared for some backlash here from your CPA when you tell her what you are doing. She’s going to look at you over her black-rimmed glasses like you have lost your mind, but it is an INVESTMENT that will pay off. The important thing to remember is Investors buy based on GAAP/accrual basis financials. Many small businesses do their books on tax basis or cash basis accounting. Why? Tax basis or cash basis accounting minimizes short-term Net Income. When we sell or value a business, we seek to maximize the Net Income because buyers buy and value a business based on EBITDA (Net Income plus interest, taxes, depreciation and amortization) which is a derivative of Net Income. GAAP accounting maximizes Net Income. If you look at publicly traded companies, they do their financial reporting on a GAAP basis. Why? So they look good to their investors! This is precisely what you want to do when selling your business.
- Pay more taxes. When the IRS forces you to go to accrual accounting pay your taxes and be happy to do it because the investment will pay dividends of 875%. I never thought I’d say this with all of the government waste (another topic, another time), but it is FAR BETTER for you to pay your taxes when positioning to sell a business. Here’s the math: For every $1 you increase EBITDA you get $3.5 more dollars of selling price. For every $1 you show as income on your taxes it costs you roughly 38 cents in taxes. Invest 38 cents to get $3.5. Now let’s convert that to real numbers. If you show an additional $100,000 of income, depending on the tax bracket you are in, you’d pay $40,000 of taxes. If you show an additional $100,000 of EBITDA, you would get $350,000 of income at the time of sale. The question I ask is: would you rather have $40,000 in your pocket now or $350,000 in your pocket in the future? Spending $40,000 to make $350,000 is an 875% return on your money. Where else are you going to get an 875% return?
By Rick Krebs – Mergers and Acquisitions Professional, Business Broker, CPA. Rick Krebs brings a unique blend of sales, entrepreneurial, and financial experience to Business Sales Group. He began his career as a CPA, working in Nevada and Utah where valuable financial experience was gained. He uses those skills every day. He graduated with a Master’s of Science Degree and Bachelor’s Degree from Utah State University. As a business owner he started Liberty Mortgage, a mortgage bank licensed in 23 states nationwide. Rick Krebs eventually sold the successful company to an investor from California. He has been in the M&A space helping people sell their businesses since July, 2010. During his first year as a business broker with BRC, he listed and sold more businesses than the entire office combined.
As a sale-side and buy-side advisor for Mergers and Acquisitions transactions Rick’s advisory, accounting, and management skills are invaluable when advising sellers as they maneuver the intricate details of the deal through closing. Rick is also a CNA (Certified Negotiation Expert) which helps him negotiate the most favorable terms for clients in a transaction.
Rick Krebs - Business Broker / M&A Professional 